CWS Market Review – December 3, 2010

The good news is that the stock market had very strong rallies on Wednesday and Thursday. The S&P 500 finished the day on Thursday at 1,221.53. This means it’s now within striking distance of taking out 1,225.85 which was the close on November 5th. That close was the S&P 500’s highest close since September 19, 2008 which was the Friday of the week that Lehman went bankrupt. In short, we may soon make a 26-month high.

The bad news is that the bold prediction I gave you last week for Jos. A Bank Clothiers’ ($JOSB) was terribly wrong. Let me offer my apologies. I was expecting blow-out earnings of 57 cents or more. As it turns out, JOSB only made 45 cents per share. Ugh! The consensus on the Street was for 50 cents per share.

Let’s break it down: Joe Bank’s third quarter comprises the months of August, September and October. The problem is that sales started off slowly in August. The CEO blamed the poor sales on hot weather. Eh…I’m a little skeptical, since according to my experience, August is always pretty darn hot. He also said the election was a distraction which sounds plausible. The good news is that the CEO said sales for Q4 look strong so far. In his defense, it doesn’t take a big distraction in retail to dent the bottom line.

After the earnings report was released on Wednesday, the stock plunged 6.7%. Actually, that’s better than it could have been. The stock closed slightly higher on Thursday, but it largely sat out the broad-based rally.

As disappointed as I am in JOSB, the larger picture is that this is still a well-run outfit. The company has now delivered record earnings for 36 of the last 37 quarters, including the last 18 consecutive quarters.

For them, and for many other retailers, the fourth-quarter is hugely important. For the first three quarters of this year, JOSB has made $1.61 per share. The current view on Wall Street is that they’ll make $1.42 for the fourth quarter. That estimate may get peeled back over the next few weeks since analysts got burned this time.

My view: I’m not ready to abandon JOSB. I still think it’s a good stock, but I’m lowering my buy price from $50 to $43. If you own it, you ought to stick with it.

There was other good news this week. I was impressed by the ISM number for November which came in at 56.6. Any boring number in the mid-to-high 50s is good news. This means that the economy continues to expand. Technically, any ISM reading over 50 means the economy is growing, and this was the 16th-straight month that the ISM has been greater than 50.

We also had a very strong report for the Chicago PMI, and the reported third-quarter productivity was revised higher. If all this sounds a little overly-technical, I can boil it down in a simple statement: things are getting better. Now we can truly say that there are green shoots out there.

There is, of course, one major weak spot and that’s employment. There are still 15 million Americans out of work and many more who have left the labor market. The old wisdom is that employment is a trailing indicator, meaning it picks up after other indicators have turned around. That makes sense given that a business won’t start hiring until after its business has picked up and the current staff feels strained.

This time around, the employment situation hasn’t been lagging as much as it’s been evenly timed with the economy to make things worse. Fewer jobs have meant more foreclosures which has meant more troubled banks which has meant fewer loans which has meant lower profits which has meant…fewer jobs. Rinse, repeat.

On Friday we’ll get the employment report for November. Frankly, I don’t know what to expect so I’ll hold off making any bold predictions. Wall Street expects non-farm payrolls to grow by 150,000. The NFP numbers for September and October will probably be revised as well. If the employment report is stronger-than-expected, the stock market could easily take out the November 5th high.

A strong report could also mean, and I say this very speculatively, that QE2 could be pulled back. The Fed was careful in its language to say that it was spreading out its plans over a few months. That’s the major difference between a Fed rate cut and QE2. The first is an event. The second is a process.

I want to return to a theme I stressed a few months ago because I think this is a crucial aspect of today’s market. The market is shifting away from low-risk assets and is rewarding higher-risk assets. This is exactly what the Federal Reserve wants and it’s happening before our eyes.

Let me give you an example. On Wednesday and Thursday, the S&P 500 rose by 2.16% and 1.28% respectively. That’s a pretty nice gain. On the same days, the yield on the 30-year Treasury rose by 14 basis points and 10 basis points respectively. The pattern is out of bonds and into stocks.

It’s not just out of stocks; look at which kinds of stocks. Jeff Cos at reports that “one in three growth managers took out their benchmarks, while just 18 percent of value managers have done the same.”

You can also see what’s happening with cyclical stocks. The Morgan Stanley Cyclical Index rose by 3.13% on Wednesday and by another 1.68% on Thursday. That’s a huge two-day move. The Cyclical Index closed Thursday at 994.64. It hasn’t closed above 1,000 since May 20, 2008.

To give you an idea of how strongly the cyclicals have rallied, the index was at 283.04 on March 9, 2009. Bear in mind that we’re not talking about one stock but rather an entire index of stocks. It’s up more than 250% in just 21 months. If the Dow had kept pace, it would be at 23,000 today.

Just look at a stock like Caterpillar ($CAT) which is a member of the Cyclical Index. You might be inclined to dismiss CAT as a boring Old Economy stock. To some extent, it is. But the stock is up 11% in the last month and up 55% since the start of the year. (The company also made news recently when it had a major bond offering…denominated in Chinese yuan.)

I’m just using CAT as an example, but this is the kind of stock that’s in the market’s sweet spot. I continue to like stocks Wright Express ($WXS) and Fiserv ($FISV) as well as old standbys like AFLAC ($AFL) and Reynolds American ($RAI). I think AFL may make a run at $60 very soon.

That’s all for now. I’ll have more market analysis for you in the next issue of CWS Market Review!

Best – Eddy

Posted by on December 3rd, 2010 at 7:03 am

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.